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HCP: A Spin-Off & Dividend Cut Is Coming. But That’s A Good Thing

Aaron Levitt Jun 22, 2016


As the world ages and medical advancements continue to improve the quality of life and longevity, the prognosis for medical-related real estate continues to improve. From hospital spaces to seniors housing and rehabilitation clinics, increased healthcare-demand requires more medical real estat


That fact has directly benefited health real estate investment trust (REITs) HCP (HCP ) over the last few decades. And it has benefited its shareholders as well. HCP has become a dividend machine and was the first REIT included in the illustrious S&P 500 Dividend Aristocrats index.

However, things haven’t exactly been working in HCP’s favor lately. Problems at one of its biggest units have turned into a major headache for the firm. A headache that has caused its once-lofty share price to plunge.

But don’t worry. HCP isn’t resting on its laurels. The REIT is trimming the fat from its system and, ultimately, that will result in a better company down the road.


Skilled Nursing Not So Skilled


Today, HCP owns just north of 1,200 healthcare-related properties. That’s literally hundreds of hospitals, doctor’s offices and other medical buildings. And like other REITs, HCP doesn’t run the underlying properties, it just owns the buildings they are housed in – in other words, it sits back and collects a rent check. It’s a wonderful business to be in when it works.

The problem is, over the last year, it hasn’t been working.

HCP’s problems come from its skilled nursing segment. Skilled nursing facilities provide long-term care for patients who struggle with regular day-to-day activities. These sorts of services have suffered in recent quarters as demand has dropped. As a result, HCP has been met with several rent declines.

But the headache at skilled nursing isn’t just about a drop in demand. The problems go deeper than that. Changes in healthcare regulations have hurt what operators can charge for these services, as the majority of patients use Medicare and Medicaid. So what did some of HCP’s skilled tenants do? They knowingly overcharged Medicare anyway. With the Fed’s not enjoying being bilked, they sued HCP’s largest skilled-nursing tenant HCR ManorCare.

And while HCP isn’t directly ‘on the hook’ for the firm’s problems, it has made the business segment a huge drag on its portfolio and earnings.


Trimming the Fat


So what’s HCP doing? It’s cutting the fat from its portfolio. Following rival healthcare REIT Ventas (VTR ) lead (who had similar problems at its skilled nursing unit), HCP has decided to spin-off the properties into a separate company. That will remove around 320 problem properties from its portfolio.

The remaining 860 or so will focus on its core assets in seniors housing, life sciences and medical-office buildings. Those three areas are the strongest places to be in healthcare-related real estate and feature great long-term growth trends.

After the spin-off, HCP should generate around 54% of its business from very lucrative private-pay senior-living properties from top operators like Brookdale (BKD) and Sunrise Senior Living. With about 10,000 baby boomers turning 65 everyday, demand for senior-living facilities is set to explode over the next few decades.

Additionally, HCP’s life sciences and medical-office properties are very attractive for investors. Hospitals and research space are pretty much custom-designed for each tenant. That lends itself to long leases and limited occupancy issues.

Without the skilled nursing issues, HCP should be able to shine long term.


Ignore the Dividend Adjustment


Over the long term, HCP is going to thrive and grow like it once did. In the short term, however, investors are going to lose their ground.

That’s because about $500 million in earnings (i.e. funds available for distribution) is going to go with the new skilled-nursing REIT. That’s a lot of cash to make up and HCP won’t be able to do so. It’s going to have to “cut” its lucrative 6.6% dividend. Rival Ventas also dropped its payout when it spun-out Care Capital Properties (CCP ).

I say “cut” because the new spin-off REIT in theory should pay a dividend once it’s established, as is the case with CCP. The combination of the HCP/spin-out REIT should be equal if not greater than just HCP’s former payout.

Over the long haul and with focus on its better properties, HCP should be able to get back to handing out more cash to investors.


Wait to Buy HCP


All in all, HCP seems to be making the right moves to better itself and remove its major issue. The firm may lose its dividend aristocrat status thanks to the spin-off/dividend cut. But, that cut is actually a good thing. For investors looking to buy the healthcare giant, investing today will net you shares of the spin-off.

Considering the spin-off may not be really worth it, and HCP stock could fall as unknowing investors go crazy over the dividend cut, I’m inclined to wait to buy shares. But over the next few decades, you’ll be happy you did.

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